Our recent GigaOM Pro digital music forecast described Disruption Vectors, market forces and trends that smart companies can use to gain revenue and market share in the near term. Our analysis rated Spotify as the company best positioned along several of the most important vectors: anywhere access, discovery and the highly disruptive rent vs. buy business model. But MOG scored well on those factors, too.

Meanwhile, Spotify’s platform strategy is smart, but limited. It is using APIs to attract apps that run within its own application. Recently, it has used this strategy to tap into another Disruption Vector: the changing role of record labels. Several labels, including Universal’s Def Jam, Warner Music and indies like Matador and Domino have built apps for Spotify. But Spotify should extend its APIs beyond its own application and become a streaming music and discovery provider for other companies’ sites and apps. That way, it would gain distribution and potential partner lock-in, both of which would maximize network effects toward a winner-take all outcome.

Closed loop

Meanwhile, MOG appears to be an acquisition target for the hot headphones manufacturer Beats Electronics. Beats, in turn, is majority owned by the big mobile phone handset maker HTC. HTC could be trying to put together a device-based, closed-loop system that could create a subsidized music service, another GigaOM Pro Disruption Vector. Although Nokia tried something similar and its program flopped, Deezer and Muve have had some success screening the cost of on-demand streaming by bundling it with voice and data services via carriers. But those efforts are carrier-driven rather than tied to hardware, which already has razor-thin margins for anyone but Apple.

It’s clear that, like all digital media, digital music services need to cultivate multiple revenue sources to thrive. That includes consumer fees, advertising and, perhaps, licensing. Both Spotify and MOG sell ads, but mostly to help subsidize free trials they hope to convert to paying customers. And that’s even though MOG has an ad network to sell inventory on other music sites. Audio ads are still a tough market, but video and display ads on apps might gain new momentum from tablets. MOG has a iPad app; Spotify does not.

Digital transition underway

Fees from consumers look attractive, but they’re hard to come by. Spotify doesn’t break out its numbers, though it has said it has 3 million paying subscribers worldwide. That would represent a phenomenally high conversion rate for digital content. GigaOM Pro’s Q1 consumer survey shows that only single digit percentages of music streamers (6 percent) have paid for a music service, although four times as many (25 percent) had bought a music download in the last three months.

There are strong hints of music listening substitution. Music streamers (27 percent of the U.S. online adult population) listen to local radio stations and CDs at the same rate as the rest of the population. But the subset of streamers whose primary listening mode is streaming (8 percent of online adults) are lighter radio and CD listeners. Both groups are above-average users of music on their mobile phones.

The digital transition appears to be underway, but it’s likely to be a long slog. Players need multiple revenue streams and some means of staying power, whether that’s a sugar daddy parent company or tons of cash in the bank. Spotify has momentum, but I’d be wary of overestimating its odds to be the sole survivor in streaming music.

Updated. After nearly 11 years as a “startup,” personalized radio provider Pandora finally went public last week, raising over $230 million and debuting with a valuation of over $3 billion. It may be a labor of love, but with its focus on radio, Pandora has a better chance for mass adoption than some of the other new digital music services. Yes, I’m talking about those from Apple, Amazon, Google, Turntable and the will-it-ever-launch-in-the-U.S. Spotify. Pandora delivers a better radio experience while most of the others are aiming at a mythical “jukebox in the sky” that many users won’t need. Plus, other digital music services are trying to change, rather than enhance, well-established music listening and buying behavior.

True believers in digital music dwell on that vision of the jukebox in the sky capable of delivering any song to any device on demand, usually powered by a subscription “rental” business model. Rhapsody and Best Buy’s Napster have come closest to delivering that model in the U.S., but neither has ever been able to attract over a million subscribers at a $10 to $15 per month price. Spotify is building the same thing in Europe, with an ad-supported freemium twist to incite trial.

On-demand streaming at the price that current royalties require faces a limited market opportunity in the U.S. I’d estimate it is five to seven million subscribers. Here’s the reasoning behind that seemingly conservative number. Pandora quotes convincing data that shows 80 percent of music-listening time is spent with radio rather than one’s own collection, and most of that listening is done in the car. I did surveys at Jupiter Research that showed that music is a relatively passive background activity for most people, and that their tastes aren’t very eclectic. Most people listen to the same genres and artists they listened to in high school or college.

Likewise, although everybody listens to music, nearly half of Americans don’t buy any, and of the remainder, 25 percent account for 75 percent of the spending. A relatively small number of heavy buyers spend $200 a year, while all the other spenders buy the equivalent of a CD or two. Even a $5 per month service is historically more than most people will spend on their own music. Yet satellite radio provider SiriusXM has over 20 million subscribers paying $13 to $17 per month.

So here’s why Pandora may catch on faster and ultimately gain more customers than some of the other contenders:

It’s catering to the masses. Most people listen to a programmed mix of artists organized by genre (i.e., radio). Pandora has genre channels as well as personalized channels that are even more tuned to a user’s favorites.

It has a radio business model, with premium upside potential. While Pandora has a $12 $36 per month subscription service, 85 percent of its revenues come from its free, ad-supported product.

It doesn’t depend on people shifting from ownership to rental. Users can still buy all the music they want to own from iTunes or Amazon. The “on-demand access to everything” pitch from Spotify or Rhapsody is geared to making people shift their yearly music spending to monthly rental. And it’s still more expensive.

It doesn’t need to integrate everything. Though it seems appealing to bundle music discovery, passive and on-demand listening, and collection management, that hasn’t proven to be a killer combo for Rhapsody.

Pandora’s product and business model are aligned with existing consumer behavior, and they are adapting to mobility well. Pandora itself doesn’t have to work as hard as companies trying to justify the jukebox in the sky, and it doesn’t require as much effort from its audience as some of the new social music experiences. Pandora is taking the easy path in digital music.

Question of the week

Which digital music service will gain the most traction?

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This is David Card's personal blog. I get paid to think about the intersection of media, technology and consumer behavior. Fun, huh?